Bank stocks, in the simplest terms, should rise in line with sales of more credit for more money. Or rather that is what would happen if the banks were well-managed and the stock market was generally right. Clearly, this is rarely the case, especially in Europe. Look at the rise and fall of Spanish bank stocks over the past 18 months.
In early 2016, Spanish lenders were among those that suffered most from the wider bank sell-off. Over the past six months, by contrast, the Spanish have been among the strongest performers of all European bank stocks. Their shares have risen by 20% on average since November.
There has been no dramatic change in the management of Spanish banks over that period (unlike Italy and especially UniCredit). This year’s delays to Basel risk-weighting rules – a boon for northern European lenders – matter less for Spanish banks, which do less structured finance than their French or German counterparts.
The changing monetary-policy outlook is a bigger, although much-exaggerated, basis for the recent Spanish bank sell-off and recovery. Their franchises are heavily weighted to retail credit and most Spanish mortgages are trackers indexed to Euribor. Spanish banks have also reduced their asset-liability committee bond portfolios in recent years, which has made their revenues even more sensitive to interest-rate movements.
In October, prime minister Mariano Rajoy assembled a working parliamentary majority after 10 months of political stalemate. That moved investor focus away from Spanish politics to its economy, which is doing rather well. Senior bankers also point to external factors, such as the rebound of the Brazilian real in 2016 and the Mexican peso in 2017 – big markets for Santander and BBVA, respectively. Both only hedge part of any currency risk they see to their group profit-and-loss statements (between 30% and 50% of the risk at BBVA, between 50% and 70% at Santander).
Better international diversification is not the only reason it would be wrong to see Spanish banks in the same light as other southern European banks, especially the Italians. But if the recent recovery in Spanish bank stocks is partly a recognition of the Spanish system’s earlier action to consolidate (and to improve asset quality costs, and fee income), it may be over-enthusiastic. Investors may be overestimating the impact on returns of what is still a tentative and far-off ECB rate hike, while underestimating the remaining Spanish risks.
Most of the big Spanish banks have a non-performing asset (NPA) exposure of around 7%, though Banco Popular’s ratio is 25%, according to Berenberg. That brings up the average NPA ratio to almost 10%. Moreover, other big Spanish banks including Santander and BBVA are among the lowest-capitalized European lenders; and their capital is much more weighted to Spain than their income.
According to Bank of America Merrill Lynch research, just as last year the ECB pushed Italian banks to offload non-performing loans, now the supervisor is turning its attention to holdings of foreclosed assets, which could spell trouble for Spanish bank shareholders. Foreclosed assets make up an unusually high 40% of Spanish non-performing exposures, according to Standard & Poor’s. The resignation of Popular’s CEO, Pedro Larena, in April coincided with the announcement of a likely restatement of 2016 results due to additional provisions, of which the biggest part related to foreclosed assets.
Greater political certainty and a consequent surge of foreign appetite for Spanish assets – not pressure from the ECB – is behind a speed-up in real estate sales at BBVA, says CFO Jaime Sáenz de Tejada. BBVA sold two real-estate portfolios of €300 million in February and March. Analysts tend to agree that faster write-downs on their existing books would not be enough to force a capital raising at BBVA, or any of the other big Spanish banks except Popular. But a capital raising for a rescue-by-takeover of Popular by BBVA or Santander could amount to something similar.
Just as importantly, masking overvalued assets with growth remains tougher in Spain than almost anywhere else in Europe. Four years after Spain’s economy began an unexpected return to buoyancy, growth in consumer finance and commercial lending has failed to offset mortgage amortizations. All the listed Spanish banks except Bankinter have shrunk their domestic loan books over the last year, according to KBW.
Deleveraging should be a good thing for the longer-term health of the Spanish economy, brought low by excessive household and public debt. However, banks will struggle to boost returns by increasing their loan books. Instead, assuming Spanish bank stocks are appropriately valued now, the most valid support for further share-price rises in the next few years will be managerial improvements – lower costs and consolidation. If that means mergers between stronger and weaker banks, the gains will not come immediately to the former.